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basel committee

SubjectOperational Management in Banks

Submitted To:Sir, Khalid Sultan AnjumSubmitted ByMuhammad YounasRoll No.MBK-M-12-03MBA (B&F) Morning 6thsemester

Alfalah institute of banking and financebahauddin zakariya universitymultan

History of the Basel Committee:The Basel Committee on Banking Supervision has its origins in the financial market turmoil that followed the breakdown of theBretton Woods system of managed exchange rates in 1973. After the collapse of Bretton Woods, many banks incurred large foreign currency losses. On 26 June 1974, West Germany's Federal Banking Supervisory Office withdrew Bankhaus Herstatt's banking license after finding that the bank's foreign exchange exposures amounted to three times its capital. Banks outside Germany took heavy losses on their unsettled trades with Herstatt, adding an international dimension to the turmoil. In October the same year, the Franklin National Bank of New York also closed its doors after incurring large foreign exchange losses.In response to these and other disruptions in the international financial markets, the central bank governors of the G10 countries established a Committee on Banking Regulations and Supervisory Practices at the end of 1974. Later renamed theBasel Committee on Banking Supervision, the Committee was designed as a forum for regular cooperation between its member countries on banking supervisory matters. Its aim was and is to enhance financial stability by improving supervisory knowhow and the quality of banking supervision worldwide.The Committee seeks to achieve its aims by setting minimum standards for the regulation and supervision of banks; by sharing supervisory issues, approaches and techniques to promote common understanding and to improve cross-border cooperation; and by exchanging information on developments in the banking sector and financial markets to help identify current or emerging risks for the global financial system. Also, to engage with the challenges presented by diversified financial conglomerates, the Committee also works withother standard-setting bodies.Since the first meeting in February 1975, meetings have been held regularly three or four times a year. After starting life as a G10 body, the Committee expanded itsmembershipin 2009 and again in 2014 and now includes 28 jurisdictions. The Committee now also reports to an oversight body, the Group of Central Bank Governors and Heads of Supervision (GHOS), which comprises central bank governors and (non-central bank) heads of supervision from member countries.Countries are represented on the Committee by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. The present Chairman of the Committee is Stefan Ingves, Governor of Sveriges Riksbank, Sweden's central bank.The Committee's decisions have no legal force. Rather, the Committee formulates supervisory standards and guidelines and recommends sound practices in the expectation that individual national authorities will implement them. The Committee encourages full, timely and consistent implementation of its standards by members and, in 2012, began monitoring implementation to improve the resilience of the global banking system, promote public confidence in prudential ratios and encourage a regulatory level playing field for internationally active banks.International cooperation between banking supervisors:At the outset, one important aim of the Committee's work was to close gaps in international supervisory coverage so that (i) no foreign banking establishment would escape supervision; and (ii)supervision would be adequate and consistent across member jurisdictions. In October 1996, the Committee released a report onThe supervision of cross-border banking, drawn up by a joint working group that included supervisors from non-G10 jurisdictions and offshore centers. The document presented proposals for overcoming the impediments to effective consolidated supervision of the cross-border operations of international banks. Subsequently endorsed by supervisors from 140 countries, the report helped to forge relationships between supervisors in home and host countries.

Basel I: the Basel Capital AccordWith the foundations for supervision of internationally active banks laid, capital adequacy soon became the main focus of the Committee's activities. In the early 1980s, the onset of the Latin American debt crisis heightened the Committee's concerns that the capital ratios of the main international banks were deteriorating at a time of growing international risks. Backed by the G10 Governors, Committee members resolved to halt the erosion of capital standards in their banking systems and to work towards greater convergence in the measurement of capital adequacy. This resulted in a broad consensus on a weighted approach to the measurement of risk, both on and off banks' balance sheets.There was strong recognition within the Committee of the overriding need for a multinational accord to strengthen the stability of the international banking system and to remove a source of competitive inequality arising from differences in national capital requirements. Following comments on a consultative paper published in December 1987, a capital measurement system commonly referred to as theBasel Capital Accord(1988 Accord) was approved by the G10 Governors and released to banks in July 1988.The 1988 Accord called for a minimum capital ratio of capital to risk-weighted assets of 8% to be implemented by the end of 1992. Ultimately, this framework was introduced not only in member countries but also in virtually all other countries with active international banks. In September 1993, the Committee issued a statement confirming that G10 countries' banks with material international banking business were meeting the minimum requirements set out in the Accord.The Accord was always intended to evolve over time. It was amended in November 1991. The1991 amendmentgave greater precision to the definition of general provisions or general loan-loss reserves that could be included in the capital adequacy calculation. In April 1995, the Committee issuedan amendment, to take effect at end-1995, to recognize the effects of bilateral netting of banks' credit exposures in derivative products and to expand the matrix of add-on factors. In April 1996, anotherdocumentwas issued explaining how Committee members intended to recognize the effects of multilateral netting.Basel II: the New Capital FrameworkIn June 1999, the Committee issued a proposal for a new capital adequacy framework to replace the 1988 Accord. This led to the release of the Revised Capital Frameworkin June 2004. Generally known as "Basel II", the revised framework comprised three pillars, namely:1. minimum capital requirements, which sought to develop and expand the standardized rules set out in the 1988 Accord;2. supervisory review of an institution's capital adequacy and internal assessment process; and3. Effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices.The new framework was designed to improve the way regulatory capital requirements reflect underlying risks and to better address the financial innovation that had occurred in recent years. The changes aimed at rewarding and encouraging continued improvements in risk measurement and control. Committee member countries and several non-member countries agreed to adopt the new rules, although on varying time scales. Thereafter, consistent implementation of the new framework across borders became a more challenging task for the Committee. One challenge that supervisors worldwide faced under Basel II was the need to approve the use of certain approaches to risk measurement in multiple jurisdictions. While this is not a new concept for the supervisory community - the Market Risk Amendment of 1996 involved a similar requirement - Basel II extended the scope of such approvals and demanded an even greater degree of cooperation between home and host supervisors. To help address this issue, the Committee issuedguidance on information-sharingin 2006. In the following year, it followed up with advice on supervisory cooperation and allocation mechanismsin the context of the advanced measurement approaches for operational risk.

Towards Basel III:Even before Lehman Brothers collapsed in September 2008, the need for a fundamental strengthening of the Basel II framework had become apparent. The banking sector had entered the financial crisis with too much leverage and inadequate liquidity buffers. These defects were accompanied by poor governance and risk management, as well as inappropriate incentive structures. The dangerous combination of these factors was demonstrated by the mispricing of credit and liquidity risk, and excess credit growth.Responding to these risk factors, the Basel Committee issuedPrinciples for sound liquidity risk management and supervisionin the same month that Lehman Brothers failed. In July 2009, the Committee issued a further package of documents to strengthen the Basel II capital framework, notably with regard to the treatment of certain complex securitization positions, off-balance sheet vehicles and trading book exposures. These enhancements were part of a broader effort to strengthen the regulation and supervision of internationally active banks, in the light of weaknesses revealed by the financial market crisis.In September 2010, the Group of Governors and Heads of Supervisionannouncedhigher global minimum capital standards for commercial banks. This followed an agreement reached in July regarding the overall design of the capital and liquidity reform package, now referred to as "Basel III". In November 2010, the new capital and liquidity standards were endorsed at the G20 Leaders Summit in Seoul and subsequently agreed at theDecember 2010 Basel Committee meeting.The enhanced Basel framework revised and strengthen the three pillars established by Basel II. It also extended the framework with several innovations, namely: an additional layer of common equity - the capital conservation buffer - that, when breached, restricts payouts of earnings to help protect the minimum common equity requirement; a countercyclical capital buffer, which places restrictions on participation by banks in system-wide credit booms with the aim of reducing their losses in credit busts; a leverage ratio - a minimum amount of loss-absorbing capital relative to all of a bank's assets and off-balance sheet exposures regardless of risk weighting (defined as the "capital measure" (the numerator) divided by the "exposure measure" (the denominator) expressed as a percentage); liquidity requirements - a minimum liquidity ratio, the liquidity coverage ratio (LCR), intended to provide enough cash to cover funding needs over a 30-day period of stress; and a longer-term ratio, the net stable funding ratio (NSFR), intended to address maturity mismatches over the entire balance sheet; and Additional proposals for systemically important banks, including requirements for supplementary capital, augmented contingent capital and strengthened arrangements for cross-border supervision and resolution.These tightened definitions of capital, significantly higher minimum ratios and the introduction of a macro prudential overlay represent a fundamental overhaul for banking regulation. At the same time, the Basel Committee, its governing body and the G20 Leaders have emphasized that the reforms will be introduced in a way that does not impede the recovery of the real economy.In addition, time is needed to translate the new internationally agreed standards into national legislation. To reflect these concerns, a set of transitional arrangements for the new standards wasannouncedin September 2010, although national authorities are free to impose higher standards and shorten transition periods where appropriate.The strengthened definition of capital will be phased in over five years: the requirements were introduced in 2013 and should be fully implemented by the end of 2017. Capital instruments that no longer qualify as common equity Tier 1 capital or Tier 2 capital will be phased out over a 10-year period, beginning1January 2013.